Covid-19 and distressed solar PPAs in Spain

Over the past few years, the Spanish power market has become the epitome of subsidy-free renewables in Europe. Due to rising wholesale power prices and plummeting costs for large-scale PV, the Spanish solar market has built up an impressive subsidy-free pipeline. In 2018 and 2019, wholesale market revenues of PV projects exceeded the levelized cost of generation (LCOE) by up to €30/MWh. Against this backdrop, more than seven GW of solar PV projects signed a power purchase agreement (PPAs) within the last two years.

Power price risk

Historically, the Spanish power market showed an above average power price level among its European peers. Transport costs for natural gas and steam coal resulted in a premium on variable generation costs for fossil power generation compared to Central Western European markets. The revitalization of the European CO₂ emissions trading system (ETS), as well as the reintroduction of the Spanish power generation tax, strengthened this trend.

When Covid-19 reached Europe in 2020, the Spanish power market was hit full force. Spot and near-term future prices fell by around 30% in just a few weeks. Electricity was traded on the spot market below €20/MWh in April 2020. This was induced by a fall in CO₂ and gas prices, which dropped by around 20% to 40% compared to February, as well as a reduction of electricity demand. In the wake of anti-corona virus measures, Spanish power demand decreased by 15-20%.

Even though prices on the Spanish spot and futures markets show signs of recovery, three drivers stir uncertainty and volatility in long-term power price levels:

1. Natural gas prices will remain the dominant factor in this decade. High volatility, especially in natural gas prices, showed high impact on power prices last year;
2. The most likely annulment in March 2021 of Spain’s power generation tax could lead to a drop of €2-8/MWh in wholesale power prices; and
3. In November 2020, the Spanish state created the legal basis to realize a total of 19.5 GW of installed renewable energy capacity by 2025 through public tenders. This will increase cannibalization of power market revenues for subsidy-free projects.

These market changes will impact existing PPAs, as well as on current negotiations for future PPAs. How pronounced this effect is on the former, depends on the specific terms and conditions of the PPA.

Distressed PPAs due to Covid-19?

Economically, the two most important parameters that can leave a PPA in distress against the backdrop of its long-term nature are the contractual volume and price. In case of volume, the supplier is obliged to deliver a certain volume which the buyer is obliged to offtake. Furthermore, in case of a fixed-price agreement, the seller hedges himself against a decrease in market prices, but also forgoes opportunities that might arise from increasing market prices. For the buyer, the opposite holds, i.e., they hedge themselves against increasing market prices and forgoe chances stemming from decreasing market prices.

However, in 2021, Covid-19 had, and still has, a strong impact on all economic aspects in Spain, not only on the electricity market spot prices . This may lead to difficulties for the seller in making the contractual volumes available, e.g., due to construction delays. The buyer may be hit by the sharp decrease in both electricity prices as well as demand, which may be particularly burdensome e.g., for tourism/industrial consumers whose services or production has been halted.

Depending on the conditions and the risk allocation agreed upon in a particular PPA, these developments could lead to a significant shift in the contractual economic balance and put the PPA in distress, depending on how long the current situation will last. It is, therefore, of paramount importance for both sellers and buyers to assess the impact of Covid-19 on the economic balance of their PPAs and possibly initiate further steps.

Restructuring distressed PPAs

Distressed PPAs are characterized by the fact that the economic disruption, i.e., the difference between PPAs and market prices, takes on extreme proportions, not only in the short term but also over a longer period of time.

When restructuring distressed PPAs, it is therefore important, in addition to the purely economic quantification of the disruption, to know one’s own legal position, in order to be well prepared for the upcoming negotiations with the contracting parties, investors, and financial institutions. Being well prepared means knowing one’s own strengths and weaknesses, in order to achieve the best possible adaptation to the new economic circumstances.

Legal requirements: Force Majeure or “Rebus sic stantibus”

One’s own legal position, i.e., the legal room for maneuver in negotiations, is primarily determined by the contractual provisions in the PPA itself. Usually, the contracting parties have included appropriate stabilization clauses in the contract, such as “hardship”, “force majeure”, “material adverse change”, etc. In short, these are exceptional agreements that combine special legal consequences in the event of an extreme, long-term disruption together with the prerequisite of “unforeseeability” and “external influence”.

In principle and until not long ago, Covid-19 was considered an unforeseeable event and thus opened up the scope of application of stabilization clauses. This applied in any case to the power generation sector, especially with regard to plants that were recently under construction in 2020 and whose commissioning, and thus the start of electricity sales, were eventually delayed by the pandemic.

However, this only applies to contracts negotiated and concluded in Spain before March 13, 2020. Contracts relating to Spain that were concluded after this date were generally negotiated with knowledge of the possible risks posed by the pandemic, i.e.,  government-imposed restrictions (lockdown, restriction of freedom of movement, etc.).

In these cases, the requirement of “unforeseeability” does not apply because the state restrictions were known to the contracting parties as of this date. The contracting party that is prevented from performing due to governmental measures to contain the pandemic can, therefore, not invoke the contractual stabilization clauses, but is obliged to compensate the other party.

In future contracts, the potential impact of Covid-19, including the viral mutations that occur, the subsequent waves of infection, and the impact of vaccination on staff and the parties own performance obligations, should be explicitly agreed in the contract.

In contrast to power generation, PPA-based power trading cannot easily invoke Covid-19 as an exceptional event that exempts from performance (delivery or payment). While short- and medium-term changes in the market price due to the effects of the pandemic do not in principle exempt the seller from the obligation to perform (e.g., the corresponding EFET provisions), the buyer will under certain circumstances be able to enforce a reduction in the quantity delivered if it is unable to meet its purchase obligation due to government measures (e.g., closures of companies, production plants, etc.).

The decision of a company’s management team to close a plant in order to protect its staff, on the other hand, cannot be qualified as “external influence” and consequently does not release the buyer from its purchase obligation on the basis of a stabilization clause.

Legal consequences: Interruption, adjustment, termination, default (insolvency)

The legal consequences, which are foreseen or imposed either by contract or by applicable law, range from the temporary interruption of contractual obligations, through to the adjustment of obligations to the new economic situation, up to the termination of the contractual relationship.

What all these legal consequences have in common is that they override the principle of “pacta sunt servanda”, which allows the contracting parties, by way of exception, to interrupt, modify, or even terminate the contract. If no contractual agreement has been reached, the respectively applicable contract law (contract statute) must be consulted with regard to the legal consequences in the event of a massive breach of contract.

Most legal systems have such an exception (“clausula rebus sic stantibus”), either in the statute law or developed by case law, according to which adherence to the contractual obligations in the case of the above-mentioned disturbances is considered unreasonable.

In extreme cases, the insolvency of one of the contracting parties has to be expected, which in turn can regularly result in the unilateral termination of the contract by the new and external insolvency administrator. In this respect, it is essential that the planned restructuring to avoid a winding-up is bankruptcy-proof, according to the new Spanish Insolvency Law. Under certain circumstances, the restructuring will be carried out within the framework of a scheme of arrangements to prevent insolvency.

Alternative Dispute Resolution and PPA

The restructuring of a PPA can be either amicable or contentious. Basically, three stages can be distinguished in the area of ADR: negotiation, mediation or commercial arbitration.

1. Negotiation

During negotiations, it is up to the contracting parties themselves to find their own conflict resolution. In practice, this often happens informally at the lower project level. Quick success is achieved without much effort and by simple means. However, a common mistake in this type of conflict resolution is the inadequate documentation of the agreement. Therefore, the contracting parties should take the time to record the agreement precisely and in writing (e.g., minutes) and simultaneously check and eventually renegotiate the drafted agreement from a legal and fiscal point of view. Experience has shown that without adequate “self-discipline” in conflict resolution, an initial “simple solution” can later turn into a complicated negotiating position that can put one party at a considerable disadvantage in contentious proceedings.

With regards to conflict resolution through negotiation, this has also undergone considerable professionalization in Spain in recent years. Well-organized companies plan and train their employees in this respect and thus achieve great economic advantages in a critical and time-sensitive conflict situation. Furthermore, if both contractual partners have agreed on a “collaborative project management”, it is possible to resolve the conflicts transparently and according to clear distribution rules (joint cost allocation via Painshare/Gainshare principle).

2. Mediation and Expert Determination

Mediation of a PPA dispute is characterized by the inclusion of a neutral third party in the conflict. As in negotiations between the parties, successful mediation or conciliation requires that the parties to the PPA are able to clearly define and structure the content of the matter in dispute and then, with the help of the mediator, jointly formulate restructuring solutions. The ultimate goal of PPA-mediation is the amicable resolution of the dispute by the parties involved. If this is not successful, the parties in dispute may request the help of a neutral expert to submit a (binding or non-binding) proposal for conciliation.

3. Arbitration on PPA disputes

As an alternative to mediation, or even after a failed mediation attempt, the contractual parties to a PPA may determine, through an arbitration agreement, that an arbitration tribunal composed of one or three arbitrators shall decide their dispute around a PPA restructuring dispute. The parties may choose the arbitrators themselves, and thus take into account their particularly desired technical and/or linguistic skills and other experiences. The parties will also determine the language or languages of the proceedings, as well as the place of the proceedings. The proceedings are confidential. The decision of the arbitral tribunal, the arbitral award, binds the parties in the same way as a decision of a state court. Especially for limited conflict amounts, i.e. in disputes of up to €3 million, some arbitration institutions, e.g., ICC, have developed an abbreviated procedure that provides for a streamlined and simplified procedure.

In general, parties in a PPA may primarily decide to agree to arbitration proceedings for solving all disputes that may arise out of or relating to the PPA itself. PPAs are quite technical and specific agreements which require independent individuals with high expertise on such matters to analyze and resolve the disputes. In this regard, it is common that PPAs indeed include ICC arbitration clauses.

The venue and the language of the arbitration proceedings may differ from the parties participating in the PPA. The confidentiality of the arbitration proceedings also makes this kind of dispute resolution attractive. Out of many arbitral institutions, the International Court of Arbitration of the International Chamber of Commerce is one of the most usual arbitrations in PPAs. Their procedures can be tailored and shortened, even more, so that solutions to disputes can be obtained in less than six months. Last but not least: the new ICC Rules 2021 provide adequate “virtual proceedings” (e.g., videoconference hearings) to cover all practical needs and protection especially with regard to Covid-19 related issues.

About the authors

Rödl & Partner is one of the leading Spanish law firms on international ADR / Arbitration in the energy sector. ICC Spain is the oldest and most important ADR/Arbitration institution in Spain. Enervis’ well recognized energy market experts have a long track record in advising its clients in arbitrations and legal disputes from an energy market perspective.